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As readers know, I have been unable over the years to resist my deflation obsessed friend Rick Ackerman's taunts. For years and years he's argued that when the credit bubble collapses, the US economy will devolve into a 1930s style deflation spiral with prices falling for years, 25% unemployment, soup lines, and perhaps a return of the Jazz Age. His latest is a response to heat he's getting from his readers to the completely unprovoked attack we launched against the deflationist camp last week with Deflationista takes on iTulip to prove deflation is here! and The truth about deflation.
Over the weekend Rick shot me a note to point out the Sunday New York Times article on deflation: "Even the New York friggin’ Times is onto the story now – on the front page, no less."
This was followed by Rick's latest on deflation that says in part:
"In any event, we’d suggest that readers imbibe articles about the economy in USA Today, the Times, the Wall Street Journal et al, with a grain of salt. The mainstream media did not see this disaster coming and even now seem incapable of imagining how much worse it could get. Conventional news outlets are barely paying lip service to those whose forecasts have been ahead of the curve for years. The truth is, deflationists were regarded as fringe lunatics until relatively recently. Writing for Barron’s and the San Francisco Examiner, we had the subject all to ourselves until around 1998, when the collapse of the Thai baht and its spillover effect on Asia brought a few more like-minded “lunatics” out of the woodwork.
I’ve promised to don a grass skirt and dance a hula in Times Square in mid-February if I am wrong. I wonder what Wall Street will look like with Goldman at $24.
Here's my response. I’ve promised to don a grass skirt and dance a hula in Times Square in mid-February if I am wrong. I wonder what Wall Street will look like with Goldman at $24.
Rick,
I always enjoy receiving your notes, but you’ve got to be kidding. Is it possible that you and I both live in the same country, the United States of Goldman Sachs? We both know that our Minister of Finance Henry Paulson’s company recently turned–presto!–into a commercial bank so that it could absorb the assets of failed banks at a fire sale prices. The perks won’t stop there. Yet you say that our Minister’s firm can suffer an ignominious a decline in share price?
Think Gosbank, man!
The disinflationary period we’ve been warning about years before the housing bubble popped, producing asset price deflation and spilling over–if only briefly–into commodity prices and wages, is here. Now all you have to do to see it is look out the window. Your mistake is that you can’t see past it to what is on the other side.
Government, and lots of it!
I sent you the picture of capital flows years ago when you were saying that the Fed can't print to save the soon to be crashed banks. Take another look. It shows what I figured was due to happen when the endogenous credit markets blew up and recession hit households and businesses during the asset price deflation. In a phrase, fiscal stimulus.
Ever go to Japan? I’ve been there several times over the past 20 years. Japan may be famous among economists for its “deflation” but if you go I recommend you bring lots of money because everything is very, very expensive there for us hapless Americans whose currency has been devalued.
Not so bad for the Japanese, though. From 1999 to 2007, Japanese wages climbed 8% while the CPI (theirs isn’t as phony as ours, by the way) fell 2.3%. Stuff got slightly cheaper relative to wages, but not exactly the USA’s 1930s Great Depression. Unemployment never exceeded 5.4% there either–not even close to the 9% unemployment we got here in the US in 1983. Here, after our first bubble in tech stocks popped, it was the other way around: our government's reflation policy after the last “deflation” in 2002 caused consumer prices to increase more than wages, up 24% and 23% respectively since then.
(Hat tip to member Bill for locating the research)
This chart shows what Japan did when its asset bubble popped and its “balance sheet recession”–a euphemism for debt deflation–followed. New Deal, pal, 1990s style. Note government spending produced more than half the total demand for credit in some years.
We’ll do “better” than that. In fact, we already have. How much has the Fed expanded its balance sheet already? How much of the housing bubble is already on the US government’s balance sheet? And that was the last bubble, the first fiscal stimulus ever done in reverse–first the jobs then the government spending rather than the more traditional order of stimulus then jobs.
Whether Obama or McCain wins tomorrow, you can bet that public money will flow like water over Niagara Falls, but to different places. The question isn’t money or not, deflation or not, it’s where to? Orange Country for the military industrial complex or Massachusetts for biotech? Coal or nuclear? Fox News or Frontline?
Where will the money come from? Why, from all of us, my friend! The future savings of the current and next generation are already spent. For the next ten years at least we’re all just cash flow to pay down debt while government spending generates the demand that creates the jobs that generates the income we use to pay down the debt.
Good news! No deflation spiral in Japan or here. The bad news: more government and less private markets. Definitely less consumption. The only way to avoid a slow, grinding decline in our standard of living is a new productivity miracle. Tell the Silicon Valley guys and gals to crank it up! We need another invention like the Internet, but this time let’s not give it away. Wonder how much export income we lost by not licensing the Internet to China? Not that they'd actually pay–they'd rather buy Treasury Bonds than shell out license fees for the hundred million Microsoft software licenses they've pirated.
Look, you got the current crisis driven dollar rally part right years ago. Good work. Now look beyond it. A dollar rally ain’t deflation. It’s a panic out of stupid investments in securities not denominated in dollars. What’s the trade? When it ends so does some of the source of disinflation. Not to say it won't go on longer, but markets appear to already be pricing in what comes next.
Ask yourself this: In the face of crashing global markets and a developing world-wide depression, why does oil hang stubbornly above $60, a “bubble” price just two years ago? Do commodity markets smell a global orgy of government spending on the way? Also, last we checked, governments aren't all that good at finding commodities, only at taxing them once someone has gone to the trouble and expense of finding and producing them. That's why Mexico and Russia seem to have suddenly run out of oil, coincident with taxation creating disincentives to invest in exploration and kleptocrats chasing off anyone with know-how out the country. (That's not an ad for either McCain or Obama, by the way. It's just a cold, hard fact.)
Add it all up and it's disinflation then inflation, just as we’ve been saying for years. Disinflation first–it's here–followed by inflation–it's coming.
The mainstream press, as you know, fulfills an important function in the execution of monetary policy. When the stories on inflation reached fever pitch last year it was time to get out of commodity positions, just as when deflation made the front page in 2002 it was time to back up the truck and buy gold. In this disinflation/deflation cycle–and it's a big one!–maybe we shouldn't wait for the next Deflation: Making Sure "It" Doesn't Happen Here speech from Bernanke like the one he gave November 22, 2002 when gold was trading at $316.
We may have to wait a while for the shots of you hula dancing in Times Square, but we're patient. We promise to post them here on the front page of iTulip.com.
Your pal,
Eric
iTulip Select: The Investment Thesis for the Next Cycle™
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